Right from the Start?

What Milton Friedman can teach progressives.

Most importantly, in Friedman’s mind, the government has a very powerful and necessary role to play in keeping the monetary and banking system working smoothly through proper control of the money supply. If there was always sufficient liquidity in the economy–enough, but not too much–then you could trust the market system to do its job. If not, you got the Great Depression, or hyperinflation. Thus, it was Friedman’s belief that the government was required to undertake relatively narrow but crucially important strategic interventions in order to stabilize the macroeconomy–to keep production, employment, and prices on an even keel.

In this, Friedman was in the same chapter, if not on the same page, as John Maynard Keynes, the economic giant of the previous generation whose doctrines and influence Friedman worked tirelessly to supplant. The Great Depression had convinced Keynes that central bankers alone could not rescue and stabilize the market economy. To Keynes, stronger and more drastic strategic interventions were needed to boost or curb demand directly. Friedman and his coauthor Anna J. Schwartz argued in their Monetary History of the United States that this was a misreading of the lessons of the Great Depression, which in Friedman’s view was caused by monetary mismanagement (or perhaps could have been rapidly alleviated by skillful monetary management). Over the course of 40 years, his position carried the day: Federal Reserve Chair Ben Bernanke holds Friedman’s view, not Keynes’s.

Nevertheless, Friedman was not an advocate of a fully automatic system, such as a gold standard. Under a gold standard it is possible for the money supply to collapse. If people start to fear that the banks to which they have entrusted their savings are shaky, they will go to the banks and–under a gold standard–demand that the banks give them their money back and give it back in gold. But with each dollar in gold that depositors withdraw, any banking system has to call in perhaps five or more dollars’ worth of loans in order to raise cash to keep from being overwhelmed by demands for liquidity. Fear on the part of depositors leads to a drying-up of capital and liquidity for businesses, and ultimately to economic depression.

It is here that Friedman and Schwartz felt the Fed had made its key mistake during the Great Depression. The stock market crash of late 1929, the recession that had already begun that June, the existing agricultural depression, and other news that shook confidence in the banking system led depositors to withdraw money from their bank accounts. The calling-in on loans that followed led to a steep fall in the money supply, in the liquidity of the economy. And the Federal Reserve stood by. It did not–as Friedman thought it should have–take every active step it could to keep the economy liquid. It did not furiously print currency. It did not frantically buy Treasury bonds for cash from all comers. Instead, it followed what it thought was a “neutral” monetary policy. And it was this neutrality that, in Friedman’s view–and in Bernanke’s, as well as my own–made the Great Depression so great. This is not exactly the same view as Keynes, but the differences are smaller than most people realize.

To be sure, Friedman always said that he favored a minimalist government, a “night watchman” state only–but a government nonetheless. Establish property rights. Enforce contracts. Prevent violence and theft. Defend the country. Keep the economy liquid by keeping the monetary aggregate M2 on a stable growth path. That, to him, was a minimalist government. But the last of these sticks out like a sore thumb: What is so special about the banking industry that the government must respond to a fall in demand for its services (for that is what going to the bank to pull out your deposit in gold constitutes) by providing it with a huge, immediate subsidy (for that is what buying up banks’ Treasury bonds for cash at their normal valuation constitutes)? And, if Friedman’s detailed study of the banking sector led him to make an exception from laissez-faire for this industry, who is he to say that a similarly detailed study of other industries would lead to similar conclusions about useful deviations from laissez-faire? And we have not mentioned that the “night watchman” state is itself a very powerful enterprise, able to make and enforce its own judgments about who owns what against not just against roving bandits, but local notables and even its own functionaries. Friedman’s minimal state is not so minimal, after all.

Friedman felt that his ideal state was the right one, but someone who reaches a different formulation can still agree with him on many of the same first principles. Indeed, it is by following through on these tensions in Friedman’s thought that I, at least, am able to feel the power of his arguments and yet retain my own uneasy combination of neoliberalism and social democracy.

This is not to say that Friedman’s legacy is all positive. Indeed, One of his closest ideological fellow travelers, Judge Richard Posner of the Seventh Circuit, worried about Friedman’s “dogmatic streak,” which took his “belief in the superior efficiency of free markets to government as a means of resource allocation” as “an article of faith, and not ” a hypothesis.” Posner claims that Friedman found the ability of Scandinavian nations, particularly Sweden, to achieve and maintain very high levels of economic output despite very high rates of taxation almost to be a personal affront. And, in the long run, this faith crippled the intellectual movement of which he was the head. Sometimes government failures are greater than the market failures for which they purport to compensate. Sometimes they are not. We badly need a sophisticated, flexible, and reality-based intellectual toolkit to analyze different cases. We do not have one, in part because Friedman’s anti-government faith blocked his spear-carriers from helping to develop it.

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